A recommendation from the recent Charities Act Review could mean charities with annual operating expenses over $140,000 will be required to disclose information about the reserves they hold, and why they hold them. This information will also be available to the media and general public.
If this disclosure becomes an obligation for registered charities, I expect this information to also be demanded from non-charitable NFPs’ stakeholders including members, funders or communities.
If this sounds alarming, it shouldn’t be, but you do need to plan ahead for this change.
Think of it as an opportunity for your organisation to review the levels and possible uses for your reserves, and consider how you’ll effectively report on them to stakeholders, funders, employees, donors, and the public. It’s also a chance for you to consider whether you’re getting the most from your reserves.
How much should we have in reserves?
Naturally, it depends on the nature and size of your organisation, so there’s no single answer to this except that all NFPs should have some reserves.
Our 2022 Not for Profit sector survey found around 75% of NFPs could survive for at least six months on their current reserves, which is encouraging; the other 25% have yet to reach this level. But others have dramatically more: 11% of NFPs say they could operate for five years or more on their reserves.
Without more context five years does rather feel like a lot.
Reserves are typically used for the following purposes and activities:
- Costs of winddown: If you lost your income or had to shut down tomorrow, how much cash do you need to pay redundancies, or meet lease commitments to ensure an orderly shutdown?
- “Rainy day” fund: Some cash is held to offset any large, unexpected costs, delays in funding or errors in forecasting. The amount of this reserve depends on how reliable your income sources are and how fixed your costs are
- Large asset purchases: This may only happen every three to five years, but you need to put aside money each year for things like buildings, cars, databases and IT equipment
- Tools, materials or knowledge that are developed across multiple years
- Expected annual deficits for the next two years while making changes to the organisation
- Cover drops in investment income or values
Many NFPs use six months’ worth of costs as a target for reserve – and this is better than nothing, but we do recommend a more structured approach like developing a formal reserves policy (see below).
How do we measure our reserves?
A word of caution: the equity amount in your balance sheet is not your reserves total. Your current reserves total is the assets you could turn into cash reasonably quickly less your current commitments (creditors, holiday pay, loans etc).
You may have significant assets like databases, furniture and IT equipment on your balance sheet, but these should be excluded from your calculation of reserves as they would raise little cash if you sold them.
How should we communicate our reserves?
Many organisations display their reserves in their balance sheets or in the financial statement notes. However, I recommend a supplementary page to your financial statements to help readers easily understand how much you have in your reserves and why you have them.
The New Zealand Public Service Association has some great examples of how to display reserves which can be downloaded here along with our guide to creating a plain English reserves policy.
Should we have a reserves policy?
Yes. A reserves policy is a critical governance process to assist in the sustainability of your organisation and to achieving your strategy over the long term. It should include the following information:
- A description of why you have certain reserves and the trigger points for using them
- Each reserve should be linked to risk, that is, degree of probability and level of impact (low, medium, high, very high)
- A description of the level of funds required in each reserve, how this is calculated and a comparison of current level versus target
- Perhaps some guidance for each reserve around the type of investment that can be held to fund them. For example, your base line reserve should be held in a form that is easily turned into cash, whereas a reserve to move buildings in six years’ time could be held in a longer term, less fluid form
- Details about the process to review the policy, when it was reviewed last, and who can authorise changes
If you have a statement of investment policy and objectives (SIPO), this should be aligned with your reserves policy. You can also use your reserves policy and SIPO to help guide your investments.
A catalyst for positive change
It would be great to see the proposed changes from the Charities Act Review become a catalyst for NFPs to think carefully about how they use their reserves – especially reserves held in cash or property.
Property can be a repository of huge reserves for some organisations. If your NFP owns several buildings, are they underutilised? Review your portfolio and ask yourself: Are we getting the best out of our assets?
If you have significant cash or term deposits, have you spoken to a professional investment advisor to see if you are getting the best chance for returns in a way that would align to your strategy and organisational risks?
This proposed change might seem onerous at first, but if it gives your organisation the impetus it needs to improve financial stability or performance – even by a fraction – it will quickly pay for itself.